One of the very first questions every single entrepreneur must ask when they’re starting off is “What type of entity should my business be?”
This might be a difficult decision for a new entrepreneur to make without understanding all of the major differences between the types of entities available.
So should you form an LLC or a Corporation? The answer is, it depends. Where do you want your potential business to be in the next one to five years? The answer to this question depends on your vision and the type of business you will have.
Before you make a decision, you have to understand how each type of entity works…
A Corporation is a legal entity created to conduct business. Once formed, they become a separate entity from the people who founded or manage it. Its owners or shareholders have ownership of the company reflected by shares or stock in the company. Corporations are formed by filing a Certificate Of Incorporation. They are usually managed by a board of directors that is selected by the shareholders and officers appointed by the board, who oversee the corporation’s day to day operations.
Corporations also shield their owners, directors, and officers against personal liability. Generally, a corporation’s debt is not considered the debt of its owners, so the shareholder’s personal assets are protected.
Also, a corporation’s structure, which allows for two types of shares (common and preferred), is usually favored by investors and venture capital firms when they are going to invest capital into a company. Examples of companies that generally structure as a corporation are:
- Technology Startups (HealthTech, Fintech, FashionTech, etc.)
- Media companies (e.g. Facebook, Amazon, Netflix, Hulu)
- Online marketplaces (e.g. Amazon, eBay, Wish)
- Mobile applications
- New-to-market or innovative customer product (e.g. Apple, Go-Pro, Fitbit)
- Companies with multiple subsidiaries
The downside to Corporations is that they require maintaining corporate formalities such as regular board meetings and board resolutions, annual shareholder meetings, they must keep corporate minutes and adequate books and records. Another downside is that the shareholders of the corporation pay taxes twice on the business earnings, through corporate income tax (both federal and state) and any earnings distributed to shareholders in the form of dividends are taxed on their personal income tax returns.
Are you a Startup that is looking to raise capital, issue stock option plans for employees or create a highly innovative product? You’re probably looking at becoming a Corporation.
Limited Liability Company
A Limited Liability company, or LLC, is a hybrid between a partnership and a Corporation. It is owned by one or more people who are referred to as members. They are generally either managed by one or more of its members or by a manager appointed by the members. It is usually favored for its simplicity and lesser formalities, which generally only require having an Operating Agreement, which establishes all the rules regarding the operation of the company. Like corporations, LLC’s also provide protection to its members against personal liability.
LLC’s have a simplified tax structure. Unlike corporations, LLC members are only taxed once, since LLC’s do not pay taxes as an entity and their profits and losses are only taxed on each member’s individual tax returns.
The downside of LLC’s is that they do not offer any shares or stock to reflect the member’s ownership which could discourage any potential outside capital investments. Examples of companies that often structure as a corporation are:
- Services (tax preparation, consulting, marketing, event planning)
- Certain consumer products (clothing, makeup, skincare, accessories)
- Food-Service Industry (restaurant, ice cream parlor, sandwich shop, convenience store)
- Lifestyle services (yoga and dance studio, gym, spa, nail salon, hair salon)
Are you looking to offer your services to the general public, have a product you wish to distribute for others to sell or open a brick and mortar location in the food industry? An LLC might be your best option.
The choice you make is going to depend on the industry your business will be in and how you plan to fund your business.
If you’re looking to raise capital, you should definitely consider forming a Corporation. If you need a simplified business structure that will protect you personally, you’re probably looking to create an LLC due to its tax flexibility and personal asset protection.
If you’re still unsure what entity to choose, reaching out to a lawyer for advice is recommended. At Benemerito Attorneys At Law, we offer free consultations and would love to help guide you toward the right decision for your business.
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This blog is for informative purposes only. This information does not constitute legal advice. You should consult with a licensed attorney that can advise you according to your particular circumstances.